IAS 2: inventoriesIAS 16: Property, plant & equipment

IFRS 3: Business Combinations IFRS 5: non-current assets held for sale and

discontinued operations

P7- ADVANCED AUDIT AND ASSURANCE

Prepared by:Andreas PapaconstantinouGiorgos SavvaGiorgos AntoniouChristoulla Demetriou

IAS 16 Property, Plant and Equipment

IAS 16 Property, Plant and Equipment

• Overview• IAS 16 Property, Plant and Equipment outlines the

accounting treatment for most types of property, plant and equipment. Property, plant and equipment is initially measured at its cost, subsequently measured either using a cost or revaluation model, and depreciated so that its depreciable amount is allocated on a systematic basis over its useful life.

IAS 16 Property, Plant and Equipment

• Objective of IAS 16• The objective of IAS 16 is to prescribe the

accounting treatment for property, plant, and equipment. The principal issues are the recognition of assets, the determination of their carrying amounts, and the depreciation charges and impairment losses to be recognised in relation to them.

IAS 16 Property, Plant and Equipment

• Recognition• Items of property, plant, and equipment should be

recognised as assets when it is probable that:• it is probable that the future economic benefits associated

with the asset will flow to the entity, and• the cost of the asset can be measured reliably.• This recognition principle is applied to all property, plant, and

equipment costs at the time they are incurred. These costs include costs incurred initially to acquire or construct an item of property, plant and equipment and costs incurred subsequently to add to, replace part of, or service it.

IAS 16 Property, Plant and Equipment

• Measurement subsequent to initial recognition• IAS 16 permits two accounting models:• Cost model. The asset is carried at cost less

accumulated depreciation and impairment. • Revaluation model. The asset is carried at a

revalued amount, being its fair value at the date of revaluation less subsequent depreciation and impairment, provided that fair value can be measured reliably.

IAS 16 Property, Plant and Equipment

• Example of non compliance• No charge of depreciation at year end.• Some PPE carried at cost and some others on

revaluation value.

IFRS 5 — Non-current Assets Held for Sale and Discontinued Operations

• Overview• IFRS 5 Non-current Assets Held for Sale and

Discontinued Operations outlines how to account for non-current assets held for sale (or for distribution to owners). In general terms, assets (or disposal groups) held for sale are not depreciated, are measured at the lower of carrying amount and fair value less costs to sell, and are presented separately in the statement of financial position. Specific disclosures are also required for discontinued operations and disposals of non-current assets

IFRS 5 — Non-current Assets Held for Sale and Discontinued Operations

• Held-for-sale classification In general, the following conditions must be met for an asset (or

'disposal group') to be classified as held for sale:I. management is committed to a plan to sell II. the asset is available for immediate sale III. an active programme to locate a buyer is initiated IV. the sale is highly probable, within 12 months of classification as

held for sale (subject to limited exceptions) V. the asset is being actively marketed for sale at a sales price

reasonable in relation to its fair value VI. actions required to complete the plan indicate that it is unlikely

that plan will be significantly changed or withdrawn

IFRS 5 — Non-current Assets Held for Sale and Discontinued Operation

• Classification as discontinuing• A discontinued operation is a component of an entity that either has

been disposed of or is classified as held for sale, and: [IFRS 5.32]• represents either a separate major line of business or a geographical

area of operations• is part of a single co-ordinated plan to dispose of a separate major

line of business or geographical area of operations, or• is a subsidiary acquired exclusively with a view to resale and the

disposal involves loss of control.• IFRS 5 prohibits the retroactive classification as a discontinued

operation, when the discontinued criteria are met after the end of the reporting period.

IFRS 5 — Non-current Assets Held for Sale and Discontinued Operation

• Non compliance• No active market• Value above the fair value • Classified as NCA held for sale and the entity

used the asset to perform its activities

IFRS 3: Business Combinations

Introduction

A business combination is a transaction or other event in which a reporting entity (the acquirer) obtains control of one or more businesses (the acquiree).

• IFRS 3 does not apply to the following:- the formation of a joint venture• - the acquisition of an asset or group of assets that is

not a business• - a combination of entities or businesses under

common control

The acquisition method

Business combinations are accounted for using the acquisition method, i.e.,

• - identifying the acquirer• - determining the acquisition date• - recognizing and measuring the identifiable assets

acquired and the liabilities assumed and any non-controlling interest and

• - recognizing and measuring any goodwill or a bargain purchase

KEY ISSUE

• A key concept underlying IFRS 3 is that of purchase price allocation, where the cost of an acquired business is analyzed into the value of all its components:

Tangible net assets, such as property, plant and equipment

Intangible net assets, such as brands and customers

Goodwill, being the balance

Control - DEFINITION

• Ownership of more than half the voting rights of another entity

• Power over more than half of the voting rights by agreement with investors

• Power to govern the financial and operating policies of the entity under statute/agreement

• Power to remove/appoint majority of directors

Recognition and measurement The acquisition date is the date on which the acquirer

obtains control.• Recognition principle:

• separate recognition of identifiable assets acquired, liabilities and contingent liabilities assumed.

• Measurement principle:• assets and liabilities that qualify for recognition are

measured at their acquisition-date fair values• measurement at fair value provides relevant information

that is more comparable and understandable.

Goodwill Goodwill (an asset) is measured initially

indirectly as the difference between the consideration transferred, excluding transaction costs in exchange for the acquiree’s identifiable assets, liabilities and contingent liabilities.

Goodwill (continued)If the value of acquired identifiable assets and liabilities

exceeds the consideration transferred, the acquirer immediately recognizes a gain (bargain purchase).

• Goodwill is not amortized, but is subject to an impairment test.

• If less than 100% of the equity interests of another entity is acquired in a business combination, non-controlling interest is recognized.

• Choice in each business combination to measure non-controlling interest either at fair value or at the non-controlling interest’s proportionate share of the acquiree’s identifiable net assets.

MAIN ISSUES

The main issues regarding IFRS 3 include:• - the costs associated with acquisition are included in

the consideration transferred rather than being expensed

• - changes in the recognized amount of contingent consideration affect goodwill

• - goodwill is amortized over its estimated useful.• - non-controlling interest must be measured using the

proportionate share method

EXAMPLE OF NON-COMPLIANCE• A company X acquired another company Z for just over £928

million, allocating £319 million to intangible assets, and £936 million to goodwill. The intangible asset value was allocated to a ‘black hole' category of ‘other intangibles' without further explanation. There was no allocation of value to marketing related intangibles including brands. There is no real justification for the allocation to goodwill of an amount approximately equal to the acquisition cost.The lack of information in this instance is remarkable and makes it difficult to form any views on the transparency of the acquisition. Even so the allocation to intangible assets again looks to be too low and the allocation to goodwill correspondingly too high.

IAS 2: inventories

The standard

• Under the standard, inventories should be stated at the lower between cost and net realisable value.– Cost includes: purchase price (net of any trade discount),

conversion cost (i.e. materials, labour, overheads) and other costs necessary to bring the inventory to its present location and condition (i.e. ready to sell)

• Cost should not include any foreign exchange differences, no matter how big they are.

– Net realisable Value is the higher between:• value in use and • selling price less cost to sell

The standard (cont.)

• When inventories are sold, the carrying amount is recognised as an expense in the period in which the related revenue is recognised.

• Any write-downs to NRV are recognised as an expense in the period of the write-down.

• Reversals from an increase in NRV are recognised in the period in which they occur.

Inventory in the Financial statements

• The auditor should as part of they audit perform stock-count, or have a substantial presence during the stock down (should the company has effective internal audit department to which the auditor can rely).

• Possible irregularities would be:– Stock-count to be overstated– Obsolete stock not adjusted for– Inventory value not stated as per the standard

Non compliance (example)

• Company A has stated all inventory (total of 8 types of inventory) at cost.

• During the audit, auditors have obtained evidence (from the selling invoices of the period following the audited period) that the NRV of 3 types of inventory items is lower and in further enquiries has also found that approximately 4% of inventory relates to sales returns with complain from the clients for malfunctions.